[2001] 2 F.C. 608
A-514-99
2001 FCA 14
Lerric Investments Corp. (Appellant)
v.
Her Majesty the Queen (Respondent)
Indexed as: Lerric Investments Corp. v. Canada (C.A.)
Court of Appeal, Richard C.J., Rothstein and Malone JJ.A.—Toronto, February 1; Ottawa, February 9, 2001.
Income tax — Income calculation — Deductions — Small business deduction — Whether real estate investment company investing and carrying on business through co-ownership or joint venture “specified investment business” or “active business” within ITA, s. 125(7)(a), (e)(i) where employees working for co-ownership or joint venture rather than directly for corporation — Incorrect to allocate fractions of full-time employees of co-ownerships or joint ventures to co-owning or joint venturing corporation to satisfy “more than five full-time employees” requirement.
Taxpayer had interests in eight apartment projects, which it owned with other co-owners or joint venturers. The principal purpose of taxpayer’s business was to derive income from property in the form of rents. The sole issue was whether taxpayer’s business was a “specified investment business” within the meaning of paragraph 125(7)(e) of the Income Tax Act. If it is, it is excluded from the definition of “active business” in paragraph 125(7)(a) and is not entitled to the small business deduction provided by subsection 125(1). The question was whether the words “employs in the business throughout the year more than five full-time employees” include employees of joint ventures or co-ownerships in which a corporation is a joint venturer or co-owner. The concept of specified investment business was introduced into the legislation to ensure that “active” meant truly active and the object of the new legislation was to ensure that the business of a corporation that invested in rental properties not be considered “active” unless there was sufficient activity in the corporation to justify the employment of over five full-time employees.
The Tax Court Judge rejected the approach set forth in Interpretation Bulletin IT-73R5, concluding that to allocate fractions of employees to a joint venturer or co-owner fell outside the realm of reality. This was an appeal from that decision.
Held, the appeal should be dismissed.
The question was whether subparagraph 125(7)(e)(i) applies where, as here, a corporation’s business is carried on through joint ventures or co-ownerships and the employees work for them rather than directly for the corporation. The determinative phrase is “the corporation employs” and this connotes a direct relationship between the corporation as employer and the specified employees. There cannot be double or triple counting of the same employee. To attribute more than five employees to a corporation simply because it has a fractional interest in a co-ownership or joint venture that employs more than five employees would be to ignore the context in which the words “the corporation employs” are used in paragraph 125(7)(e). Nor does the wording of the legislation allow for an allocation approach whereby employment is allocated to each joint venturer based on its interest in the property. It is the co-owners or joint venturers together, not independently, who employ the workers. No joint co-owner or joint venturer can say that it individually employs the workers or portions of them. All they can say is that they are responsible for a percentage of each employee’s wages. Even if the provision can lead to illogical results, the Court’s duty is to take the legislation as found.
STATUTES AND REGULATIONS JUDICIALLY CONSIDERED
Income Tax Act, S.C. 1970-71-72, c. 63, ss. 125(1) (as am. by S.C. 1984, c. 45, s. 40; 1988, c. 55, s. 102), (7)(a) (as am. by S.C. 1984, c. 45, s. 40), (e) (as am. idem).
CASES JUDICIALLY CONSIDERED
NOT FOLLOWED:
Canada v. Hughes & Co. Holdings Ltd., [1994] 2 C.T.C. 170; (1994), 94 DTC 6511; 80 F.T.R. 243 (F.C.T.D.).
AUTHORS CITED
Canada. Department of National Revenue. Taxation. Interpretation Bulletin, IT-73R5, February 5, 1997.
APPEAL from a decision of the Tax Court of Canada (Lerric Investments Corp. v. Canada (1999), 99 DTC 755) dismissing taxpayer’s appeal from assessments with respect to its 1990, 1991 and 1992 taxation years which disallowed the small business deduction provided by subsection 125(1) of the Income Tax Act. Appeal dismissed.
APPEARANCES:
Theodor Kerzner, Q.C., for appellant.
Marie-Thérèse Boris for respondent.
SOLICITORS OF RECORD:
Kerzner, Papazian, MacDermid, Toronto, for appellant.
Deputy Attorney General of Canada for respondent.
The following are the reasons for judgment rendered in English by
[1] Rothstein J.A.: This is an appeal from a judgment of Bowman T.C.J. (as he then was) dismissing the appellant’s appeal with respect to its 1990, 1991 and 1992 taxation years [(1999), 99 DTC 755]. The sole issue is whether the appellant’s business is a “specified investment business” within the meaning of paragraph 125(7)(e) of the Income Tax Act [S.C. 1970-71-72, c. 63 (as am. by S.C. 1984, c. 45, s. 40]. If it is a specified investment business, it is excluded from the definition of “active business” in paragraph 125(7)(a) [as am. idem] and is not entitled to the small business deduction provided by subsection 125(1) [as am. idem; S.C. 1988, c. 55, s. 102].
[2] At the relevant time, subparagraph 125(7)(e)(i) read:
125. (7) …
(e) “specified investment business” carried on by a corporation in a taxation year means a business (other than a business carried on by a credit union or a business of leasing property other than real property) the principal purpose of which is to derive income from property (including interest, dividends, rents or royalties), unless
(i) the corporation employs in the business throughout the year more than five full-time employees, or
FACTS
[3] I cannot improve upon the concise statement of relevant facts of the learned Trial Judge and I reproduce them here [paragraphs 3-10]:
It is admitted that the principal purpose of the appellant’s business was to derive income from property in the form of rents. The sole issue is whether the appellant throughout each of the three years in question employed more than five full-time employees.
The appellant had interests in eight apartment projects, which it owned with other co-owners or joint venturers. In none of the projects was it a partner.
The following schedule sets out the number of full-time employees employed at each project by the joint ventures in which the appellant had an interest, and its percentage of ownership:
| Joint Venture |
# of Full Time Employees |
% Ownership |
| Sheridan Twins |
4 |
16.67 |
| The Diplomat Apartments |
2 |
20.00 |
| Humber Park Apartments |
2 |
15.00 |
| Lyon Manor |
1 |
25.00 |
| 839 Roselawn |
1 |
50.00 |
| Ivory Towers |
1 |
17.50 |
| Hyland Park Apartments |
1 |
15.00 |
| Rhona Towers |
3 |
20.00 |
The above schedule is for 1990. For 1991 and 1992 the percentages remain the same, and the only difference is that in 1991 Humber Park Apartments had three employees and in 1992 it had four employees.
If one applies the percentage of ownership in each project to the number of employees at each project, the result will be a notional attribution of a fraction of a full-time employee to Lerric.
For 1990 the calculation made by the appellant looks like this:
| Joint Venture |
# of Full Time Employees |
% Ownership |
Allocated to Lerric |
| Sheridan Twins |
4 |
16.67 |
0.67 |
| The Diplomat Apartments |
2 |
20.00 |
0.40 |
| Humber Park Apartments |
2 |
15.00 |
0.30 |
| Lyon Manor |
1 |
25.00 |
0.25 |
| 839 Roselawn |
1 |
50.00 |
0.50 |
| Ivory Towers |
1 |
17.50 |
0.18 |
| Hyland Park Apartments |
1 |
15.00 |
0.15 |
| Rhona Towers |
3 |
20.00 |
0.60 |
| Lerric |
2 |
100.00 |
2.00 |
| Total Number of full |
|||
| Time Employees |
5.05 |
For 1991 and 1992, the percentage changes slightly because Humber Park Apartments had three employees in 1991 and four in 1992. This meant that the allocation to Lerric in respect of Humber Park in those years was 0.45 and 0.60 respectively, and the total allocation rose to 5.20 and 5.35.
The appellant had two full-time employees in addition to those employed at the various apartments.
[4] In the Tax Court, the appellant relied on Interpretation Bulletin, IT-73R5, paragraph 16.
16. If, for example, two corporations carry on a business in partnership as equal partners with the partnership business employing more than five full-time employees, each partner would, for the purpose of paragraph (a) of the definition of “specified investment business” in subsection 125(7), be considered to employ more than five full-time employees. However, if the business is carried out by corporations in a joint venture or other form of co-ownership, the total number of full time employees who work jointly for all the co-owners must be allocated to each co-owner in accordance with the co-owner’s percentage of interest in the property.
ISSUE
[5] On the facts of this appeal, the question is whether the words in subparagraph 125(7)(e)(i) “the corporation employs in the business throughout the year more than five full-time employees” include employees of joint ventures or co-ownerships in which a corporation is a joint venturer or co-owner.
REASONS OF THE TRIAL JUDGE
[6] The Trial Judge accepted that it is difficult to ascertain whether and how that provision applies in circumstances such as this. He therefore turned to the scheme of the legislation. At paragraphs 23 and 24 of his reasons, he sets out the object and purpose of the provision. I agree with his explanation.
The concept of specified investment business seems to have been a response to certain decisions of the courts which treated virtually any commercial activity of a corporation, however passive, even where it was carried [sic] under contract by independent contractors who were not employees, as an active business (see, for example, The Queen v. Cadboro Bay Holdings Ltd., 77 DTC 5115 (F.C.T.D.); The Queen v. Rockmore Investments Ltd., 76 DTC 6157; E.S.G. Holdings Limited v. The Queen, 76 DTC 6158; The Queen v. M.R.T. Investments Ltd., 76 DTC 6158).
The result was the introduction of the concept of specified investment business the purpose of which [sic] to ensure that “active” meant truly active and that the word not be, in effect, judicially written out of the Act. Therefore the object of the new legislation was to ensure that the business of a corporation that invested in rental properties would not be considered “active” unless there was sufficient activity in the corporation’s business to justify the employment of over five full-time employees.
[7] He then found that the appellant employed two full-time employees and shared the expenses of 15 others. He rejected the approach of IT-73R5 because [at paragraph 26]:
To allocate fractions of employees (.15 to .67) to a joint venturer or co-owner strikes me as outside the realm of reality and I would be surprised if whoever wrote the bulletin considered the situation with which we are concerned here.
[8] His final conclusion was that each case was fact dependent and that real estate investment companies who invest through co-ownerships or joint ventures may not be excluded from subparagraph 125(7)(e)(i) in all cases. However, he was of the opinion that it was necessary to [paragraph 27] “draw the line where one’s good sense tells one to draw it”. He dismissed the appellant’s appeal.
ANALYSIS
[9] Section 125 distinguishes between active and inactive corporations, only the former being eligible for the small business deduction. Ordinarily, a business whose income is primarily derived from property is treated as inactive and therefore ineligible for the deduction. Subparagraph 125(7)(e)(i) provides an exception to this rule and allows the small business deduction to a corporation that derives income from property where that corporation is sufficiently active—employment being the indicia of activity. As Bowman T.C.J. explained, the requirement that the corporation employ more than five full-time employees simply operates as a test to ensure that a corporation is sufficiently active such that it should qualify for the deduction.
[10] Employing the words of the learned Trial Judge found at paragraph 16 of his decision, the fundamental question posed by subparagraph 125(7)(e)(i) is whether a corporation’s business is sufficiently active that it uses more than five employees. However, before the question of sufficient activity can be raised, it is first necessary to ask who is it that the corporation employs in its business.
[11] Subparagraph 125(7)(e)(i) is straightforward when a corporation is carrying on business on its own. If the corporation employs more than five full-time employees throughout the year in its business, the requirement of subparagraph 125(7)(e)(i) will have been met.
[12] However, the question here is whether it is possible to construe the words of subparagraph 125(7)(e)(i) to apply if a corporation’s business is carried on through co-ownerships or joint ventures and the employees work for the co-ownership or joint venture rather than directly for the corporation.
[13] There are two approaches under which the corporation could be considered to employ more than five full-time employees for purposes of subparagraph 125(7)(e)(i). The first approach reasons that, because a co-ownership or joint venture is not a legal entity separate and distinct from its co-owners or joint venturers, each employee can be said to be employed by each co-owner or joint venturer. Put another way, this argument implies that the same employee can be a full-time employee of each and every co-owner or joint venturer. In the relevant taxation years, this approach would attribute 15 to 17 full-time employees to Lerric, depending upon the taxation year in question. I do not think such an approach is consistent with the words of subparagraph 125(7)(e)(i) in their context.
[14] The words of the provision that are determinative are: “the corporation employs”. In my opinion, having regard to the context of paragraph 125(7)(e), that it is a measure of business activity, this crucial phrase connotes a direct relationship between the corporation as employer and the specified employees. If a corporation employs a full-time employee, I do not see how, in the context of paragraph 125(7)(e), the same employee, providing a single service, can be simultaneously employed full time by another employer to whom that employee provides exactly the same service. This approach involves double, triple, or even multiple counting of the same employee. To attribute more than five employees to a corporation simply because it has a fractional interest in a co-ownership or joint venture that employs more than five employees ignores the context in which the words “the corporation employs” are used in paragraph 125(7)(e).
[15] The other approach in which full-time employees could be said to be employees of a co-owner or joint venturer individually is if their employment is allocated to each co-owner or joint venturer in accordance with an allocation formula, e.g. one based on the co-owner’s or joint venturer’s interest in the property. In the relevant taxation years, this approach would attribute 5.05 to 5.35 full-time employees to Lerric, depending upon the taxation years in question.
[16] This allocation approach does not suffer from the same impediment as the first approach, i.e. double or multiple counting of the same employees, such that the same employee is considered to be employed full-time by more than one employer. Also, as the Trial Judge found, mathematically, it meets the numerical test of subparagraph 125(7)(e)(i), i.e. more than five.
[17] However, I do not think the allocation approach is envisaged by the words of sub-paragraph 125(7)(e)(i). As I have stated, the provision simply conceives of a single corporation employing more than five full-time employees. There are no words in the provision that imply that a proportional or sharing approach of the same employee by different employers is contemplated.
[18] I am not convinced of the correctness of the view expressed in Canada v. Hughes & Co. Holdings Ltd., [1994] 2 C.T.C. 170, at paragraph 37, that the “more than five full-time employees” requirement means at least six full-time employees and could not be met by a single corporation employing five full-time employees and one part-time employee. All that is necessary is that the employer employs more than five full-time employees. However, I think that an approach which allocates fractions of full-time employees of co-ownerships or joint ventures to a co-owning or joint venturing corporation to satisfy the “more than five full-time employees” requirement would involve reading words into the provision that were not placed there by Parliament.
[19] The appellant, with some justification, asks who employs the employees working in the co-ownership or joint venture if the employer is not each co-owner or joint venturer. The appellant’s view is that the co-ownership or joint venture is not a separate legal entity and, therefore, the employees must be employed by each co-owner or joint venturer.
[20] The Minister’s answer, and it is one that I must accept, is that it is the co-owners or joint venturers together, but not independently, who employ the employees. No co-owner or joint venturer can say that it individually employs the employees or portions of the employees. They can say that, in accordance with the co-ownership or joint venture agreement, they are responsible for a percentage of each employee’s wages. However, this does not give rise to the allocation of fractional employees and the aggregation of these fractions to meet the “more than five full-time employees” test in subparagraph 125(7)(e)(i).
[21] The Minister says the provision is an arbitrary proxy for an active business and it may not accommodate every deserving situation. I am forced to agree with the Minister. It is not difficult to construct anomalies which demonstrate that either the application or non-application of subparagraph 125(7)(e)(i) to co-ownerships or joint ventures leads to illogical results. However, applying an arbitrary rule to situations not contemplated by the rule will have that effect because it is arbitrary. Be that as it may, it is the duty of the Court to take the statute as it finds it.
[22] The appeal will be dismissed with costs.
Richard C.J.: I agree.
Malone J.A.: I agree.